Post-COVID fatigue

CHILE - Report 28 Dec 2023 by Igal Magendzo

The latest Central Bank Monetary Policy Report offers a surprisingly positive outlook for economic activity. But, in our view, activity remains stagnant. The only good news comes from the construction sector, which appears to be at a potential turning point, after hitting historical lows. The industry IMACEC rebounded in October, but this upturn can be attributed to a general recovery in still-depressed wood-related activities. The negative trend of domestic demand has had a negative impact on imports, resulting in a protracted improvement of the trade balance. Exports continue to show negative 12-month variations.

The labor market maintained its fragility throughout the August-October quarter, registering only a marginal uptick in total employment. Moreover, the persistent disparity between the decline in private payrolls and the growth of the public payroll is striking. Seasonally-adjusted unemployment has inched up slightly, extending the gradual upward trend. An early recovery in employment cannot be projected.

While the CPI surprised on the downside in October, it surprised on the upside in November, and by an even greater amount. Even the Central Bank´s Monetary Policy Report recognizes that “monthly inflation data has shown high volatility in recent months.” The unexpected inflation surge in November was driven by prices exhibiting erratic and unusual behavior, as well as by new seasonal phenomena.

In line with what was implicit in market prices, but surprising most analysts on the downside, the Central Bank cut the monetary policy rate by 75bp. Perhaps in an attempt to justify this sharp monetary policy backwardation, both the communiqué and the Monetary Policy Report are somewhat optimistic about activity. Importantly, the Central Bank revised upward to 4% its estimate for the neutral policy rate.

The lack of consistency among the forecasts in the Monetary Policy Report is notable. The base scenario assumes that inflation will reach the target in H2 2024, and that the output gap will remain close to zero. This means that the conditions for the policy rate to reach its neutral value are met. However, the baseline scenario projects that by the end of 2024 the rate will still be 100bp above neutral. We expect rate cuts to be larger than those in the baseline.

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